Rental relationships when using offshores

On leasing legal relations when using offshore companies

Considering the structure of transactions for the purchase of real estate with the further intention of renting it, it is necessary to pay special attention to the optimization of revenues in the tax sphere, which are connected with this kind of operations.

This article deals with the issues of legal participation of foreign organizations (non-residents) in legal relations in the sphere of lease on the territory of Russia, taking into account some peculiarities for non-residents in matters of taxation when leasing immovable property in the Russian Federation.

1. Features of legal relationships of non-residents

According to the legislation of the Russian Federation, foreign organizations have the right to participate in the transfer of real estate for rent on the territory of the Russian Federation, taking into account the following requirements:

• as the owner of the property and the direct lessor. It is mandatory to create a permanent representation;
• as the owner or investor of the legal entity of the Russian Federation, who owns the leased object. There is a variant of building a holding company, on the lower level of which is a Russian company that owns the property to be leased. In this case, the jurisdictions of participants in a foreign holding must take into account the need to implement agreements on avoidance of double taxation, as well as financial investments in the transaction for the purchase of real estate.

Simply owning property on the territory of the Russian Federation, a foreign company is not obliged to create a permanent representative office, but when conducting certain activities of a commercial nature, according to the legislation of the Russian Federation, there is a need for a permanent representation.

According to the Tax Code of the Russian Federation (RF Tax Code), the fact that foreign organizations systematically lease out real estate, concluding lease contracts, repair and maintain premises in good condition, lead to the creation of a permanent representation.

Paragraph 2 of Article 306 of the Tax Code of the Russian Federation provides that a permanent representative office of a foreign company, as a tax agent, may be considered an agency, branch, department and other subdivision or place where business is carried on.

Therefore, the term "permanent establishment" is not an organizational and legal one, but one that conducts commercial activity, during which it becomes necessary to pay taxes on profits (the Methodology of the recommendations of paragraph 2.1)

The establishment of a permanent representative office in the Russian Federation is conditioned by the following factors:

• engaging of a person who represents the interests of a foreign company in the territory of the Russian Federation, has the right to sign agreements, contracts on the basis of the contract;
• a foreign company that carries out activities through a broker, realtor or other person who performs work in accordance with its core business, not necessarily the establishment of a permanent establishment;
• systematic carrying out of activities. The systematic activity is considered to be that is carried out during more than 30 calendar days a year. Otherwise, "regular (systematic) activity" is determined in the process of analyzing the company's activities. If the foreign organization carried out single cases of transactions, this activity can not be considered as regular;
• entrepreneurial activity aimed at obtaining profit for commercial purposes, which has registration in accordance with the procedure established by the legislation of the Russian Federation (art. 2 of the Civil Code of the Russian Federation), which can not be considered auxiliary or preparatory.

In this case, the income from leasing property is not of commercial character. If real estate is acquired for own use, and leasing it is not systematic, a foreign company has the right not to create a permanent establishment, but only to pay the necessary taxes that are withheld from the tenant.

All income from the property being leased is subject to taxation regardless of the form in which payment is made (repayment of obligations, set-off of claims, etc.). Taxes are paid in the currency received from the lessee.

When determining the amount of tax, the costs from it can not be deducted. In this case, it should be noted that if a foreign company that does not have a permanent establishment is required to be registered with the tax authorities at the place of the actual location of the property.

2. Peculiarities of taxation of a foreign company when leasing real estate

A foreign company that, through a permanent establishment, receives income from the leasing of property, is required to pay income tax at the same rate with legal entities of Russia. The tax rate on profit since 01.01.2009 is 20% (art. 284.1 of the Tax Code of the Russian Federation).

Monetary profits can be recognized as a tax base, if the income received from leasing property through a permanent establishment is deducted from the expenses associated with the receipt of this income (RF Tax Code, art. 247).

The legislation of the Russian Federation for the avoidance of double taxation introduces a provision according to which taxes on profits are imposed on that part which participates in the activities of a permanent representative office not of a resident and is attributed to it. (Methodical recommendations, paragraph 4.11)

In the absence of link with the receipt of income from the rental of real estate through a permanent establishment, the property owner is required to keep a record of expenses (income) from the rental of real estate separately from the recording or accounting of income through a permanent establishment.

If for non-residents, whose activities are carried out through the permanent establishment, the income tax is 20%, then for owners of aircraft and vessels, which are recognized as immovable property in the Russian Federation, when carrying out transportation, such tax is 10% (RF Tax Code, Article 284, sub-paragraph 2 of paragraph 2).

International transportation in the Russian Federation is recognized as marine, river, air, road and rail one. The only exception is transportation outside the Russian Federation (art. 247 sub-paragraph 7 of paragraph 309 of the Tax Code).

Non-residents who operate on the territory of the Russian Federation without the establishment of a permanent establishment have the opportunity to pay taxes at a reduced rate, taking into account the costs of this representation. But, the amount of expenses should be supported by documentary evidence and economically justified (Article 252 of the Tax Code of the Russian Federation)

The justification of costs (expenses) for the maintenance of real estate in the transfer for rent, as well as depreciation expenses, can affect the amount of paid taxes, as costs associated with production and sales.

Foreign organizations that systematically provide property for temporary use for a fee, may refer the costs of maintenance to production or as related to the sale.

To date, it is not possible to establish any criteria for systemacity in transfer of property due to imperfect legislation. Therefore, foreign companies can determine  the type of expenses to which they can include this part of the costs according to accounting records. However, we should not forget that accounting in this case is separate. (Tax Code of the Russian Federation, art. 274, para. 2).

When the property is leased through a permanent establishment, the non-resident is obliged to notify the tenant that the income received by him is related to the permanent representative office of the foreign company. At the same time, a copy of the document on registration with the tax authority of the Russian Federation certified by a notary is sent to the lessee.

If this document is not provided by the lessor in time, the lessee is obliged to act as a tax agent and pay the tax to the budget of the Russian Federation from the income that he pays to the lessor (RF Tax Code, art. 310, subparagraph1 of paragraph 2).

The excessively paid amount can be returned or credited against further payments (RF Tax Code, Article 307, paragraph 7)

If a foreign company has not registered its permanent establishment, the tax burden falls on the lessee, who in this case acts as a tax agent through a permanent establishment. The amount of tax should be paid for each transfer of funds for rent, along with payment to the lessor. (Tax Code of the Russian Federation, art.310, para. 1).

In case of violation of the terms of payment or failure to fulfill the duties of the tax agent, the lessee is brought to administrative responsibility in accordance with Article 123 of the Tax Code. Penalties amount to 20% of the unpaid tax, while the resident can not pay the debt or a fine from his own funds.

3. Features of VAT charging and payment

The value added tax in the Russian Federation according to Article 164 of Article 3 of the Tax Code is 18%. Since the rental of real estate in Russia is recognized as the provision of rental services, this type of activity is subject to VAT.

A non-resident is obliged to pay VAT independently in any variant of registration of a permanent establishment or without it. The legislation of the Russian Federation does not provide for the registration procedure for VAT. All companies that have a tax number and are registered must pay VAT.

When acquiring real estate, all non-resident owners without a permanent establishment are required to register with the tax authorities to pay property tax, and the TIN for real estate is issued.

Foreign organizations that conduct activities for the leasing of property through a permanent establishment can register with the tax authorities as VAT payers at the location of the permanent establishment.

If a non-resident has several such representative offices, he independently determines which of them will provide tax documentation and pay VAT on all other departments or branches in the territory of the Russian Federation. The non-resident is obliged to notify in writing all tax structures where his representations are located (RF Tax Code, Article 144, paragraph 2.3)

When choosing a property owner and planning the income from the transfer of property for rent, it should be clarified whether the lessee is a VAT payer.

If the lessee is not a VAT payer (Russian Tax Code, article 346, paragraph 2.3.4), it would be prudent to switch to a different variant of taxation (simplified system). This option is acceptable only if the lessor is a legal entity of the Russian Federation, since non-residents can not conduct activities under the simplified taxation system (RF Tax Code, Article 346, paragraph 3, sub-paragraph 18).

The best option when leasing property will be the same tax system for both the lessor and the lessee to exclude a conflict of interest.

4. Avoidance of double taxation with the participation of a non-resident

For a non-resident who leases a property, the following factors should be considered when selecting a jurisdiction:

1. When establishing the need to create a permanent representative office for the rental of real estate, the Agreement on the avoidance of double taxation has no advantage if compared with the legislation of the Russian Federation.
2. The above Agreement does not regulate the imposition of a tax on the profit of a non-resident.
3. The agreement does not limit the right of the country to tax a non-resident with VAT.

There are certain exceptions. For example, Clause 4, Article 9 of the Agreement between the United States and the Russian Federation of June 17, 1992 "On the avoidance of double taxation and the prevention of tax evasion with respect to taxes on income and capital" states that a US resident has the right to choose, according to a certain procedure provided for the law of the Russian Federation, the calculation of taxes on income from the use of real estate on the basis of net taxable income, as if these revenues were attributed to a permanent establishment.

The agreements are the most important for holdings. Selection of foreign participants of holdings should be made taking into account DTA provisions on interest income or taxation of dividends.

Law & Trust International provides services for the registration of offshore companies, as well as tax planning and optimization services.